Matson Navigation Co. v. Federal Maritime Commission
Docket: No. 91-1176
Court: Court of Appeals for the D.C. Circuit; March 26, 1992; Federal Appellate Court
Petitioner Matson Navigation Company, Inc. seeks judicial review of a Federal Maritime Commission (FMC) order that denied its proposed General Rate Increase (GRI) of 3.6% for commodities in its Pacific Coast/Hawaii Trade, approving instead a GRI of only 2.68%. The FMC determined that Matson’s justified rate of return on rate base is 10.18%, lower than the 10.58% Matson aimed for with the requested GRI. Matson contests this lower rate, asserting that the Commission incorrectly assessed its risk level compared to the average U.S. manufacturing firm and that the 10.18% rate is insufficient to attract capital and service debt. The court finds that the Commission's decision is supported by substantial evidence and is neither arbitrary nor capricious, thus denying Matson's petition for review. The case background indicates that Matson's rates are regulated under the Shipping Act of 1916 and the Intercoastal Shipping Act of 1933, with the FMC tasked to ensure rates are "just and reasonable." Matson’s GRI was filed on January 5, 1990, and became effective on March 10, 1990, pending determination by the Commission. The FMC’s General Order 11 establishes that the return on rate base is the primary standard for evaluating rate reasonableness, with a benchmark rate derived from the average returns of U.S. manufacturing firms, adjusted for relevant factors. The Commission accepted a benchmark rate of 11.93% but adjusted it downwards by 0.5% for current trends, a decision Matson does not contest.
Matson contests the Commission's adjustment of the benchmark for relative risk, which was modified downward by 1.25 percentage points based on the Commission's finding that Matson faced less risk than the average U.S. manufacturing firm. This adjustment, combined with a 0.5 percentage point reduction for trends in rates of return, resulted in a final benchmark rate of return of 10.18 percent, which is 0.4 percentage points lower than the 10.58 percent rate Matson would have received under the proposed 3.6 percent General Rate Increase (GRI). The Commission ultimately approved a GRI of only 2.68 percent, projecting a return of 10.18 percent.
Matson raises two main arguments against the Commission's decision: first, it claims the Commission erred in applying the G.O. 11 methodology by unjustly lowering the benchmark due to Matson's relative risk; second, it contends that the approved rate is unreasonable under the 1933 Act, asserting it is insufficient for Matson to manage its debt and attract capital.
The standard of review requires affirming the Commission's decision unless it is found to be arbitrary, capricious, or unsupported by substantial evidence. The court acknowledges the complexities of ratemaking, which demands converting imprecise data into concrete rates. The Commission's expertise is taken into account, and it is granted significant discretion in determining a "just and reasonable" rate. Additionally, the Commission is afforded extra deference due to statutory time constraints mandating expedited decision-making, which may sometimes result in less comprehensive explanations. Ultimately, the burden of proof lies with those contesting the rate order to demonstrate its unreasonableness.
The Commission's adjustment for relative risk relates to the perceived risk of investing in the regulated carrier compared to typical U.S. corporations. If the regulated carrier is viewed as riskier, the benchmark should be adjusted upward to ensure it can maintain a credit rating and attract capital. In assessing Matson's relative risk against the average U.S. manufacturer, the Commission made three key findings:
1. Matson's competitive position is unlikely to be significantly impacted by Sea-Land Service, Inc.'s announced expansion in the Hawaii Trade.
2. The Hawaii Trade is characterized as a non-contestable market due to substantial barriers to competition, providing Matson with greater protection from competition than other firms.
3. Considering these factors, the Commission concluded Matson is less risky than the average U.S. manufacturer.
Matson disputes these conclusions, claiming they lack substantial evidential support and argue that the Commission's risk reduction is arbitrary and inconsistent with previous decisions that either granted Matson upward adjustments for risk or made no adjustments at all.
Regarding Sea-Land's expansion, the Commission noted that Sea-Land, which holds about 21% of the Hawaii westbound container market compared to Matson's 75%, announced plans to double its capacity. The Commission assumed Sea-Land would proceed with this expansion but doubted it would significantly capture cargo from Matson during the Test Year. Although Sea-Land has cost advantages that could allow it to price competitively, the Commission believed it likely would continue to follow Matson's pricing strategy, competing mainly on service rather than price.
Matson challenges the Commission's conclusions, citing evidence of Sea-Land's past pricing strategies and arguing that it is economically rational for Sea-Land to undercut Matson's rates to gain market share. Matson contends that the Commission's assessment improperly substitutes its business judgment for that of Sea-Land's decision-making.
Matson contests the Commission’s reliance on the Test Year, asserting that investors will perceive increased risk due to Sea-Land’s announced expansion, regardless of when actual competition emerges. Matson argues that potential investors will recognize the competitive threat from Sea-Land, independent of its immediate impact on the Test Year. Although Matson's arguments hold merit, the court emphasizes its limited role in reviewing the Commission’s rate order, focusing on whether the Commission exercised its ratemaking authority rationally and diligently, rather than substituting its own judgment.
In evaluating Sea-Land’s past pricing behavior, Matson claims that Sea-Land has previously engaged in incremental pricing. However, the only evidence cited is that Sea-Land's rates for specific container sizes are lower than Matson’s, which does not sufficiently demonstrate a general practice of incremental pricing. As Matson had the burden of proof, the Commission's conclusion that the evidence did not establish incremental pricing was upheld.
Regarding Sea-Land’s future pricing behavior, predictions are inherently judgment-based. A Matson expert posited that Sea-Land would exploit its pricing advantage to undercut Matson’s rates for westbound cargo, while a Commission expert countered that Sea-Land typically follows Matson’s pricing strategy to avoid initiating a price war, which would be detrimental to both firms. This expert argued that it is more beneficial for both companies to maintain higher rates and compete primarily on service, given Matson's dominant market position.
Blair’s testimony is supported by Sea-Land's recent 3.6% general rate increase following Matson's proposed General Rate Increase (GRI), though this does not preclude Sea-Land from adopting a competitive pricing strategy. Matson's counsel indicated that Sea-Land could maintain Matson's pricing structure while selectively undercutting prices on profitable commodities, which Matson alleges has occurred. The Commission reviewed this conflicting testimony and ultimately favored Blair's perspective. Despite doubt about Sea-Land's commitment to follow Matson’s price leadership, especially as it expands capacity in a market with limited growth, the Commission's decision to accept Blair's plausible competitive scenario was deemed reasonable. The Commission recognized that even if Sea-Land captures some of Matson's cargo, Matson would retain a significant market share, mitigating the risk to Matson. It rejected a proposal to lower a benchmark risk assessment significantly, asserting that such a reduction did not sufficiently account for the increased competition from Sea-Land. While the Commission's justification for its conclusions could have been more detailed, it was determined that they adequately considered both short-term and long-term competitive impacts, and their decision was supported by substantial evidence, warranting deference to their expert judgment.
The Commission assessed the contestability of the Hawaii Trade to evaluate Matson's competitive position compared to manufacturing firms. Experts agreed that a contestable market requires minimal entry costs, cost-free exit, and no legal or regulatory barriers. The Commission determined that the Hawaii Trade is not contestable due to significant legal and regulatory barriers, citing the lengthy delay in American President Line, Ltd.'s application as evidence of these obstacles for carriers receiving federal operating-differential subsidies (ODS). While it acknowledged that carriers operating U.S.-flag, U.S.-built vessels without subsidies or with construction-differential subsidies (CDS) face no regulatory barriers, it noted a scarcity of such vessels—only eleven unsubsidized vessels exist in the U.S. fleet. Matson did not dispute the existence of regulatory barriers for ODS-vessels but challenged the Commission's dismissal of its evidence regarding available unsubsidized and CDS-vessels. Matson claimed the Commission improperly required it to prove the suitability of these vessels. The Commission, however, did consider the impact of the eleven unsubsidized vessels but deemed their number insufficient to establish the Hawaii Trade as contestable. It also found no error in placing the burden of proof on Matson regarding the thirty-one CDS-vessels, in accordance with legal standards. Ultimately, the Commission concluded that the Hawaii Trade is not a contestable market, and the summary judgment was upheld.
The Commission evaluated the risk levels of U.S. manufacturers compared to Matson, concluding that Matson presents a lower risk to investors. Key findings included Matson's 75 percent market share, its position as the dominant carrier even with increased competition from Sea-Land, its role as a price leader in a predictable market, and its protection from foreign competition due to the Jones Act. Additionally, Matson's Aaa credit rating is superior to that of the average U.S. manufacturer.
Matson disputed the Commission’s conclusions, arguing that its business model is more vulnerable due to its inability to stockpile production and its commitment to a single product. Conversely, Hearing Counsel's expert, Blair, asserted that U.S. manufacturers face greater competition and that Matson's legal protections are stronger. Despite Matson's objections to Blair's analysis, the Commission found sufficient evidence to support its determination of lower risk.
Matson challenged the legal basis of the Commission's reliance on Blair's comparison of Matson to a "minor firm in a multi-member less concentrated market," claiming this was a new, undefined category. The Commission clarified that this reference was contextual and did not constitute a substitution of comparison entities. Matson also criticized Blair for using sources beyond the Bureau of Census Quarterly Financial Reports (QFR) in his risk assessment. While the Commission acknowledged that ideal comparisons would involve direct risk evaluations using QFR data, it maintained that the complexity of ratemaking often necessitates broader sources for a complete risk assessment. The Commission found no legal error in relying on Blair's informed testimony despite Matson's disagreements.
The Commission recognized it was changing its policy by adjusting the relative risk downward for Matson, departing from previous investigations where it typically approved upward adjustments or made no adjustments. The evidence in this case differed significantly from past cases, where prior submissions indicated Matson was riskier than comparable firms due to historical earnings variability and business leverage. In contrast, the current evidence highlighted the Jones Act's restrictions on competition, suggesting Matson was less risky than typical U.S. manufacturers. The Commission evaluated the new evidence and justified a 1.25 percentage point reduction in the risk benchmark, supported by substantial evidence in the record. The Commission's methodology was deemed appropriate under the 1933 Act, and there was no basis to challenge the specific reduction figure.
Additionally, while G.O. 11 mandates the comparative earnings test as the primary standard for determining just and reasonable rates, the Commission allowed Matson to present evidence regarding its ability to attract capital. Acknowledging constitutional constraints against setting confiscatory rates, the Commission determined that a 10.18 percent rate of return was not confiscatory and Matson did not contest this finding. Instead, Matson contended that the Commission improperly confined its capital attraction analysis to the question of constitutional validity under G.O. 11.
Matson asserts that a rate of return can be constitutional yet still unreasonable if it hampers the carrier's ability to attract capital and service debt, referencing Banton v. Belt Line Railway Corp. Matson contends that the Commission should have applied a capital attraction test to evaluate the reasonableness of the rate rather than merely its constitutionality. The Commission, however, is not required to conduct this test as it has determined that the comparable earnings methodology meets the necessary criteria from precedent cases (Bluefield and Hope) by allowing Matson to earn a return on its rate base comparable to other investments with similar risks, thereby enabling it to maintain credit and attract capital. Matson argues that the current allowed return is only marginally above its cost of debt, preventing its equity from achieving normal returns above debt levels. Nevertheless, the court finds Matson's argument insufficient to overturn the Commission’s methodology, as it did not demonstrate systemic flaws in the comparable earnings test or provide a theoretically sound alternative that is superior. The court notes that Matson's failure to explain its calculations further weakens its position, leaving no compelling reason to impose a different methodology on the Commission.
The Federal Maritime Commission (FMC) is not required to implement a separate capital attraction test to evaluate the reasonableness of the G.O. 11 rate of return due to significant policy considerations. Following the 1978 amendment to the 1933 Act, Congress established strict timelines for the FMC’s decision-making on general rate increases, aiming to avoid delays caused by disputes over rate methodology. Consequently, Congress directed the FMC to create regulations for determining "just and reasonable" rates, during which the capital attraction test was explicitly rejected as a primary evaluation method. The FMC has since reaffirmed its preference for using the rate of return on equity as the standard for assessing rate reasonableness, finding it simpler and more effective than the capital attraction approach, especially concerning the complexities of determining the capital structure of subsidiary carriers.
The FMC concluded that imposing a capital attraction test would be counterproductive, given its prior rejection of this methodology. After reviewing the Commission's order and relevant records, it was determined that the FMC fulfilled its statutory obligation regarding the rate's reasonableness. As a result, the petition for review was denied. The State of Hawaii and Tobias E. Seaman, along with the National Association of Shippers, Consignees, and Consumers for Maritime Affairs, had protested the rate increase and were intervenors in the proceedings, although the FMC resolved five additional issues in favor of Matson Navigation Co., with no further judicial review sought on these matters. The FMC's regulations reference "comparable U.S. corporations," and it has previously deemed manufacturing firms as most comparable to shipping companies. The rate of return on total capital is calculated using net income after interest on long-term debt divided by the sum of stockholders' equity and long-term debt.
A carrier seeking a rate increase must submit its projected rate of return on rate base for a designated Test Year, which spans 12 months following the proposed effective date of the rate changes. In this case, with Matson's rate increase effective March 10, 1990, the Test Year runs from April 1, 1990, to March 31, 1991. The return on rate base is calculated as trade net income plus interest expense divided by trade rate base, with specific calculations outlined in G.O. 11. The Commission may intervene if it finds a carrier's rates unjust or unreasonable, allowing for adjustments based on relative risk. Matson's argument centers on the competitive disadvantage it faces compared to Sea-Land, which operates with a different shipping pattern and pricing structure. Matson claims it must cover full costs for cargo from the U.S. Pacific Coast to Hawaii, while Sea-Land, as a backhaul competitor, only needs to cover incremental costs, granting it a pricing advantage. Additionally, Sea-Land benefits from federal construction-differential subsidies but must repay part of these subsidies if using subsidized vessels in domestic trades. Matson does not assert that Sea-Land's freight-all-kinds (FAK) rates reflect a general pricing strategy and maintains that the nature of Sea-Land's competitive strategies—service or price—is irrelevant to its argument. The Commission also extended decision deadlines by 60 days as permitted by law.
Sea-Land aims to expand its presence in the Hawaii trade by actively seeking cargo from Matson, although Matson's concerns appear exaggerated. The Commission's differentiation between price and service competition reflects the understanding that Sea-Land intends to compete on service without aggressively undercutting prices, a point that could have been clearer but is not critical to the outcome. APL's application to enter the trade was submitted in February 1987, denied in July 1990, and is currently under review in district court. Operating-differential subsidies are intended to support U.S. vessel operations in foreign commerce. The Commission noted a decrease in the number of specific vessels available, but there is a discrepancy in the current count provided by Commission counsel during oral arguments. Under the Jones Act, domestic cargo is restricted to U.S.-built and crewed vessels. Matson claims that its operational costs remain largely fixed in the short term, leading to a reduced rate of return as traffic declines. Additionally, Matson argues that the Commission incorrectly assessed its relative risk by considering its credit rating, which is more relevant to lenders than equity investors. While Matson's profitability may safeguard its credit rating, it does not shield it from significant earnings reductions due to Sea-Land's expansion. The Commission's analysis of Matson's credit rating, as one factor in assessing relative risk, is deemed appropriate. The comparative analysis highlighted Matson's lack of foreign competition against the backdrop of increasing foreign competition under the Jones Act.
No significant legal or regulatory barriers exist for potential domestic competition in a concentrated market dominated by a price leader, while minor firms operate in a less concentrated environment. The market is characterized by defined and predictable conditions but also encompasses broader national and international markets that are less predictable. The "Lifeline" service and non-"Lifeline" goods are noted, with an expected market growth of 3.9% in the upcoming "Test" year, contrasted by slower growth and potential recession risks in the domestic market.
The reliability of data used in assessing risk, specifically the variability of earnings test, was not disputed by Matson, which argued that the absence of such analysis was improperly used by the Commission to justify a downward risk adjustment. The Commission acknowledged that past investigations presented a different risk picture due to varying evidence. The concept of business leverage was introduced, indicating the level of costs that must be met before generating net revenues.
Hawaii proposed a risk reduction adjustment between 1.0 and 1.5 percentage points, which was lower than the 1.75 percentage points proposed by Hearing Counsel. Matson claimed a distinction between statutory and constitutional capital attraction tests but failed to articulate it clearly. The Commission, referencing significant legal cases, stated that it could not set rates too low to attract capital, aligning with Matson's argument about the necessity of sufficient returns for capital attraction. Ultimately, the Commission's decisions are guided by constitutional requirements and the obligation to balance the interests of investors and consumers, emphasizing public service as the paramount concern.
